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OECD: Update on tax challenges arising from digitalisation of economy

OECD: Tax challenges, digitalisation of economy

The Organisation for Economic Cooperation and Development (OECD) released details of the next steps to be taken in studying several possible tax proposals to revise geographic allocation of taxation rights through amended profit allocation and nexus tax rules.


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In the June 2019 webcast ("Tax Talks") the OECD reviewed its "Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalization of the Economy”—that outlines how it will come to a consensus-based agreement with the international community on these tax issues.

The OECD said it will also continue to look at the proposed rules to determine that multinational enterprises (MNEs) face a minimum level of taxation, and noted that in the future, it will study the economic and potential overall effects of its proposals before it makes any final decision on new rules. It may offer public consultations on the new rules later, as the proposals are refined.


The new digital tax proposals focus on the allocation of taxing rights, including nexus issues, and typically allocate more taxing rights to market or user jurisdictions where value is created through businesses' participation in the user or market jurisdiction that is not recognized in the current framework for allocating profits. These alternatives were initially outlined by the OECD in a "Policy Note" issued January 2019, and that was followed by a consultation report in February 2019. The proposals address remaining base erosion and profit shifting (BEPS) issues and generally intend that MNEs pay a minimum level of tax, through the introduction of global anti-base erosion rules.

This recent agreement on the approach to discussing these issues was laid out by the 129 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) and published in May 2019. Read TaxNewsFlash

The planned approach was also endorsed by G20 Finance Ministers in Fukuoka, Japan in June 2019. In the report, the OECD confirmed the international community's continued commitment to reach a consensus-based long-term solution on taxation and the global digital economy by 2020.

Profit allocation

The OECD reported it is exploring three approaches to determine how much of an MNE's profit is to be allocated to market jurisdictions, and then how to allocate that profit among those market jurisdictions. The three approaches being explored are:

  • Modified residual profit split method—when a portion of a group's non-routine profit would be allocated to market jurisdictions
  • Fractional apportionment method—when an entity's profits (no distinction between routine and non-routine profits) for sales to market jurisdictions would be allocated to those market jurisdictions under a to-be-determined formula that could consider factors such as sales, users, assets and employees
  • Distribution-based approaches—when a baseline profit would be determined (including routine and non-routine profits) for marketing, distribution and user-related activities in a market jurisdiction, adjusted to reflect the MNE's overall profitability as a whole (or other factors), followed by an allocation of that return to market jurisdictions

Other issues to be discussed (and relevant for each of the approaches noted above) will include:

  • Whether profits of an affected MNE could be segmented on a regional or business line basis
  • Potential scoping limitations for the new tax, which could be based on factors such as:
    • The size of an MNE group
    • The nature of the business
  • Determining that losses are treated in a symmetrical manner as profits under the approach that is ultimately adopted
  • Identifying the relevant taxpayer (as these approaches look at the profits of an MNE as a whole, rather than on a legal entity basis)
  • Coordinating between the new profit allocation rules and the existing transfer pricing rules to avoid overlaps and potential double-taxation
  • Effective administration, including reporting obligations


A new "non-physical presence nexus rule" could allow market jurisdictions to tax certain profits generated within their borders using an alternative approach. This rule would require a remote, but sustained and significant business presence at the MNE group level (rather than the legal entity level), and could consider factors such as revenue thresholds, targeted marketing activities, and digital engagement in the jurisdiction, among other factors. The implementation of a new nexus rule could include changes to existing tax treaties, which could potentially be facilitated through the use of the multilateral instrument (MLI) or a new multilateral approach.

Global anti-base erosion rules

The global anti-base erosion rules are generally intended to provide for a minimum level of tax being paid by MNEs. Under these proposals, four separate rules are being explored, and these could provide jurisdictions with the ability to "tax back" profits that are subject to low effective rate of tax. The proposals that will be explored include:

  • An inclusion rule—under which the income of a foreign branch or a controlled entity would be taxed if that income was subject to tax at an effective rate that is below a minimum rate; this could potentially operate as a "top-up" to achieve a to-be-determined minimum rate of tax
  • A switch-over rule—which would be included in tax treaties to allow the state of residence to apply the credit method instead of the exemption method when profits attributable to a permanent establishment or derived from immovable property (which is not part of a permanent establishment) are subject to tax at an effective tax rate below the minimum rate
  • An undertaxed-payment rule—which would deny a deduction or impose source-based taxation for a payment to a related party if that payment was not subject to a minimum rate of tax
  • A subject-to-tax rule—which would be added to tax treaties to only allow certain treaty benefits if the item of income is subject to tax at a minimum rate.

What’s next?

The OECD's next steps include technical work on the various proposals by different working groups, with the first impact assessment scheduled to be completed by the fall of 2019. By the end of 2019, the OECD hopes to find a unified approach among the proposals being explored, and launch a further public consultation.

Read a June 2019 report prepared by the KPMG member firm in Canada

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